New Regulations on Charitable Donations and State Income Tax

As another rule change motivated by the Tax Cuts and Jobs Act, late last week—on August 23rd—the IRS issued proposed regulations on charitable giving that can impact our clients who live in places that have a state or municipal income tax.

Fortunately for our clients in Florida, Texas, and the five other states with no state income tax, this new ruling doesn’t affect their taxes.

However, for everyone else, IR-2018-172 was designed to clarify the impact that state and local tax credits have on the federal tax rules for charitable contribution deductions.

Under the proposed regulations, when a taxpayer who donates money or transfers property to an entity that’s eligible to receive tax deductible contributions, the taxpayer will now have to reduce their federal charitable deduction by the amount of any state or local tax credit the he/she receives.

In other words, if your state gives you a 70 percent tax credit for donations and you donate $1,000 in cash or equivalent to an appropriate entity, you would receive a $700 tax credit on your state income tax return. In that instance, the allowable deduction on your federal income tax return would be reduced to $300—$1,000 minus $700.

(The proposed regulations also apply to payments made by trusts or decedents’ estates in determining the amount of their contribution deduction.)

The exception to this calculation is if the state or local tax credit is 15 percent or less of the value donated. In the above example of $1,000 donated, the amount of the donation would not be reduced on your federal tax return, because the state or local tax credit would be $150 or less.

The proposed regulations provide exceptions for dollar-for-dollar state tax deductions and for tax credits of no more than 15 percent of the payment amount or of the fair market value of the property transferred.